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JERUSALEM, Sept 1 (Reuters) Israel is considering changing the 2007 state budget to boost spending on defence after the month-long war with Hizbollah and to rebuild the north, a senior Finance Ministry official said on Friday.

Prime Minister Ehud Olmert -- under pressure due to public perceptions he mishandled the war -- and Finance Minister Abraham Hirchson met on Thursday to discuss the issue.

They discussed raising spending by 3.3 percent in 2007 from 2006 levels instead of a planned 1.7 percent rise, said Deputy Budget Director Yossi Gordon. He said the increase would cost about 5 billion shekels ($1.1 billion).

Total 2006 budget spending is set at 272 billion shekels.

''There has been no final decision made but that's the most probable decision,'' Gordon told Reuters.

Gordon said that of the extra funds, some 2.5 billion shekels -- ''a one-time cost'' -- would go to the Defence Ministry as a result of high costs stemming from Israel's conflict with Hizbollah guerrillas in Lebanon.

Another 1 billion shekels would go towards rehabilitating northern Israel from damage caused by about 4,000 rockets fired by Hizbollah during the conflict.

Israeli newspapers noted the rest would go towards social programmes.

Gordon said that as a result of the extra spending, the 2007 budget deficit would likely be raised to around 3 percent of gross domestic product.

The Finance Ministry had planned to further implement tight fiscal policies in 2007 with a budget deficit target of 2 percent of GDP, down from 3 percent in 2006.

Until the war, it appeared Israel would handily meet its targets due to a strong economy that led to higher than expected tax revenues and on restrained state spending.

Through July, Israel had been running a large budget surplus and was forecast to post a small deficit for all of 2006.

But costs of the war were high, both in military spending and in economic damage. Many economists cut their 2006 growth estimates to 4 to 4.5 percent from above 5 percent.

To meet its 2006 targets, the Finance Ministry will shift 2 billion shekels into defence from other parts of the budget.

That plan caused a rift within the Labour Party, Olmert's largest coalition partner. Some Labour lawmakers feel the move would hurt the poor.

Ahead of March elections, Labour ran on a platform of boosting social spending and working to narrow the income gaps between rich and poor.

Before the outbreak of the war, the government sought to make good on its promises but Hirchson said spending priorities must now be reevaluated.

REUTERS SBA GC2008